Question

Companies invest in expansion projects with the expectation of increasing the earnings of its business.

Consider the case of Fox Co.:

Fox Co. is considering an investment that will have the following sales, variable costs, and fixed operating costs:

	Year 1	Year 2	Year 3	Year 4
Unit sales	5,500	5,200	5,700	5,820
Sales price	$42.57	$43.55	$44.76	$46.79
Variable cost per unit	$22.83	$22.97	$23.45	$23.87
Fixed operating costs except depreciation	$66,750	$68,950	$69,690	$68,900
Accelerated depreciation rate	33%	45%	15%	7%

This project will require an investment of $20,000 in new equipment. The equipment will have no salvage value at the end of the project’s four-year life. Fox pays a constant tax rate of 40%, and it has a weighted average cost of capital (WACC) of 11%. Determine what the project’s net present value (NPV) would be when using accelerated depreciation.

Determine what the project’s net present value (NPV) would be when using accelerated depreciation.

A. $60,717

B. $75,896

C. $68,306

D. $87,280

Now determine what the project’s NPV would be when using straight-line depreciation. ($86,887, $75,554, $94,443, 71,776)

Using the _________ (accelerated, straight line) depreciation method will result in the highest NPV for the project.

No other firm would take on this project if Fox turns it down. How much should Fox reduce the NPV of this project if it discovered that this project would reduce one of its division’s net after-tax cash flows by $500 for each year of the four-year project?

A. $931

B. $1,551

C. $1,163

D. $1,318

Fox spent $1,750 on a marketing study to estimate the number of units that it can sell each year. What should Fox do to take this information into account?

A. Increase the amount of the initial investment by $1,750.

B. The company does not need to do anything with the cost of the marketing study because the marketing study is a sunk cost.

C. Increase the NPV of the project $1,750.

Answer 1